An extremist, not a fanatic

April 10, 2012

If productivity hadn't fallen

In the day job, I say that if productivity hadn’t fallen since the end of 2007, there would now be three million fewer people in work. This is just a simple mathematical claim. But it raises the question: what would have happened if productivity had kept growing at its pre-2007 rate? Would we really now have almost six million unemployed, or would there have been some offsetting mechanism to create jobs?

One obvious possibility is that if productivity had kept growing, we would have seen more quantitative easing. This is because inflation would have been much lower, partly because firms’ labour costs would have been lower as they sacked more workers, and partly because higher unemployment would have depressed consumer spending.

But it’s unlikely that QE alone would have created so many jobs. The Bank estimates (pdf) that the first £200bn of QE raised GDP by 1.5-2%. This suggests that, to create three million jobs - a rise in employment of 12% - we‘d have needed almost £1.4 trillion of QE. That would have required the Bank to have bought every gilt in existence, and then some. Which is a big ask*.

Another possibility is that fiscal policy would have been looser, which would have created jobs. But again, this is unlikely. Higher unemployment might well have raised the deficit relative to what it would otherwise have been, causing the government to (wrongly) fear it was too big.

It’s unlikely, therefore, that policy responses to higher unemployment would have been sufficient. But are there any endogenous responses to higher productivity and unemployment that would have tended to create jobs?

You might think that the very fact that workers are more productive in this alternative universe would cause firms to hire more of them. But things aren’t so simple. Firms only hire if they anticipate sufficient demand for the additional output. And where would this demand come from? The tendency for higher unemploymentwould depress consumer spending. On the other hand, it’s likely that business investment would be higher - not least because a world of growing productivity is a world in which there are more investment opportunities and easier access to finance. But as business investment is only 8.3% of GDP, it’s unlikely that it would be so much higher as to create three million jobs.

Another possibility is that the tendency towards higher unemployment would have depressed wages even more, and this would have encouraged job creation. I suspect, though, that this would have been only a small benefit given that the price-elasticity of demand for labour, for given aggregate demand, is quite low; we know this because the minimum wage did not destroy that many jobs.

Another possibility is that sterling would have fallen more than it did. But again, this is little help given the low price elasticity of demand for exports - we didn’t get an export boom after sterling fell 20% in late 2008 - and their relatively low labour content.

My conclusion here is simple. It’s very easy to imagine that, if productivity hadn’t fallen, we would have much higher unemployment now.

Such a situation, though, would probably be even worse than the one we’re in. Not only would we have the human misery of greater joblessness, but we’d also quite possibly have serious political unrest.

Which brings me to a paradox. There is no question that, in the long-run, higher productivity is a huge blessing; it‘s this, and pretty much this alone, that makes us rich. But in the short-run, it is not such a good thing. I’m not at all sure how to reconcile these.

* A larger obstacle is that it would have required nominal corporate borrowing costs to fall below zero.

@ Doc - think of it this way. If a firm sees a potentially productive worker, it must ask before hiring him "how can we sell this guy's output?" That requires the demand to be there. Marginal productivity depends upon expected demand.

If rising productivity is such a problem, how come productivity has increased about 500% over the last century or two, yet unemployment (ignoring the regular booms and recessions) never basically changes?

Where productivity rises, given constant demand, the result will be excess unemployment: i.e. the economy running at below capacity. Government can in that case boost demand by borrowing and spending more (and/or cutting taxes). As to the debt that that causes, the government / central bank machine can print money and buy back the debt as appropriate (depending on what interest rate it is aiming for).

A more sensible policy (advocated by Milton Friedman) would involve cutting out all the borrowing cr*p, and just have government / central bank print money and spend it (and/or cut taxes) where demand needs a boost.

Isnt the mechanism via which productivity gains create demand "usually" price cuts? If firms can produce output more cheaply and they cut prices that will create demand for that firm's output and/or free up income to spend on other goods.

Presumably something else firms could do if they experience a productivity gain is hold prices and increase profits. I wonder whether the tendency for firms to do one or the other has shifted?

What are your cet.par. conditions exactly here? You hint at holding aggregate demand constant. Yet you are worried about demand being *lower* if prices had risen less? You need to get your AD curve seen to, it's bent the wrong way.

The Bank of England have been suppressing expectations of demand exactly because prices have been rising too fast. That is their mandate. They would be setting very different expectations had we had 0% CPI inflation over the last twelve months, and the same outturn for, say nominal GDP.

Labour hoarding may mean we face a jobless recovery if firms have a lot of excess capacity to use up before expanding. But hoarding also presents another problem.

While a lot of productivity growth is down to firms/plants entering and exiting the market, a lot of internal productivity growth is down to new hires. Most new hires into the skilled and "knowledge worker" roles that impact on productivity will come from existing jobs. Each recruitment has a cascade effect, creating further vacancies and churn. This amplifies productivity growth as workers are shuffled between employers.

Churn also impacts on capital investment, notably in areas like IT. New staff usually drive the adoption of new systems.

So we may be faced with a recovery characterised by both continuing high unemployment and low productivity growth, both as a consequence of labour hoarding.

Luis Enrique’s point above about productivity increases “freeing up income to spend on other goods” is much the best answer to Chris’s querie. My only quibble with it is that Luis kind of assumes that ALL the money left on consumers’ pockets as a result of productivity increases will be spent. Probably most of it will. But just to be pedantic.......

If the percentage increase in real household spending is equal the percentage increase in productivity, then there’d be no need for government to implement any stimulatory or deflationary measure (assuming the aim was to leave aggregate employment unchanged). In contrast, if for example the percentage increase in household spending was a bit less than the productivity increase percentage, then government would need to implement some stimulus (in the form of the “Milton Friedman” system I mentioned above, or whatever).

@ Gareth, Luis - the question is: by how much would demand rise as the price level falls?
The Pigou effect and the increaeed competitiveness of exports suggests demand would rise. But on the other hand, a lower price level would increase the real level of debts, potentially aggravating the recession.

Let's say the auto industry increases its productivity the price of cars falls. If you hold nominal incomes constant (why would they fall?), people can now either buy more cars or buy the same quantity of cars and buy more of other stuff instead.

Say I have a £5000 overdraft. The price of cars having fallen now makes the opportunity cost of repaying that £5000, in terms of cars, higher, but nothing has happened to make repaying my overdraft any more difficult, has it? In fact if I was planning on buying a new car anyway, I may now be able to do so and repay my overdraft more quickly. I don't see anything to aggravate the recession there.

What would cause problems to borrowers would be the price level including nominal wages falling, but that's not what we are talking about in case of productivity-induced price cuts.

I don't mean to be rude, but this post, to this outsiders is almost dumbfounding in its apparent (and I would like to stress that word) sheer Heath-Robinson wrong-headedness.

Most outsiders would find it laughable that you can suggest that increased productivity would cause problems, at least not without extensive argument!

Productivity will have declined (if labour-hoarding is believed) because demand for production declined, so workers are doing less or doing the same but less profitably.

If you then wish to examine the hypothetical case where productivity kept increasing you must pay great attention to your ceteris paribus conditions, as has already been pointed out:

"You might think that the very fact that workers are more productive in this alternative universe would cause firms to hire more of them. But things aren’t so simple."

They are so simple, almost by definition. If you have increased productivity at trend over the whole economy, then the demand is there. To consider a hypothetical where whole economy productivity keeps rising BUT this then depresses demand (and hence actual productivity) is muddle headed.

Productivity is measured in prices and volume, so if you specify high productivity, the prices x volume , and therefore demand, is there by definition.

You appear to be introducing without definition a woolly concept of "potential productivity" which cannot be not realised as true marginal productivity because of some imagined demand collapse.

As someone who nonetheless appreciates the physical reality that production of desirable goods is causally prior to (effective) aggregate demand, does this make me some kind of cultist internet weirdo?

Is it oddball to intuitively rebel at economic analysis that views lack of aggregate demand as a root cause and therefore suitable target of costly intervention?

"Which brings me to a paradox. There is no question that, in the long-run, higher productivity is a huge blessing; it‘s this, and pretty much this alone, that makes us rich. But in the short-run, it is not such a good thing. I’m not at all sure how to reconcile these."

I think you are genuinely confused by not being clear with yourself about ceteris paribus assumptions and causal priorities.

What if tomorrow the oil price goes to $10 a barrel. Productivity goes through the roof.

Would that collapse demand? Would it increase unemployment? Would it bollocks!

"But firms would need fewer workers because if they produced more towards GDP (after subtraction of these lower costs) demand would collapse!"

Course it wouldn't. It didn't before when productivity was growing. Why should it now that everyone has just got a fantastic cut in costs?

Hello, I am Chris the trawler fleet owner of Fish Island where fish are the main source and store of wealth. I'm troubled.

You see, fish stocks have fallen and each of my fishermen is catching fewer fish than in the good old days but I can afford to hoard them on reduced hours and pay.

But actually this is a good thing, since market demand for fish has collapsed. We all borrowed far too much fish so we could pay each other ever vaster sums for our luxury fishing huts and now we struggle to pay the fish interest from our reduced catch. We have had to cut down on fish purchases as you can imagine.

Whilst I recognise that catching fish is the only real long term source of wealth, I worry that if my catch had not fallen, but rather kept growing, that it would be a real problem.

I would have to fire half my fishermen. If I employed them to catch all those extra fish, demand would collapse even further. Lucky that the stocks have been completely trashed, isn't it?

OK I've switched my computer back on to apologise, in a manner of speaking - if you were talking about the hypothetical where demand drops as it as done, but firms don't labour hoard, instead firing workers (and thus keeping productivity per worker hour - labour productivity - up). This is merely a matter of income distribution effects.

But then what are you going on about when you say "There is no question that, in the long-run, higher productivity is a huge blessing; it‘s this, and pretty much this alone, that makes us rich."

Labour productivity - the thing that is being discussed as below trend in your links - isn't what makes us rich! A single man working constantly at vast productivity could not make the UK rich if the rest of the country was unemployed.

Output (or output per worker) makes a country (in aggregate or per head) rich!

And then what are you going on about worrying that you could not employ more people? Your hypothetical increased labour productivity is a direct function of employing fewer people because of an implicit ceteris paribus placed on aggregate demand. You can't specify that state of affairs and then speculate what might happen to unemployment with increased production! You have already SPECIFIED what has happened to it in your hypothetical!

Either labour productivity movements here are:

1. a mere function of dividing a fixed quantity of output between varying numbers of employees.

2. Intrinsic changes in productivity per worker due to organisation, education, technology, reduction in costs, increase in external demand etc. WITHOUT AN IMPLICIT FIXED AGGREGATE DEMAND.

If you analyse your conundrum under 1, then you are looking at a tautology, with no means to examine changes in output or demand.

If you analyse it under 2 then an increase in productivity can't possibly be a bad thing unless you apply an implicit fix on aggregate demand, which reverts the analysis to scenario 1.

Either way, it would be an improvement to be clearer in your definitions of productivity and your ceteris paribus assumptions.

The minimum wage didn't destroy as many jobs as would have been expected.

Surely that is the point. People on minimum wage utilise their income as 'consumers' and therefore generate additional demand. In a sense they are filling in a demand gap acting as a platform for further opportunities. It is counter intuitive to think that the minimum wage would destroy any jobs after the original shake out.